Implementation of comprehensive and bold policy action will help restore Europe’s recovery, the International Monetary Fund (IMF) said today in its latest Regional Economic Outlook (REO) for Europe: Navigating Stormy Waters. Growth in Europe has slowed significantly, as a result of global shocks, and of the escalation of the euro area sovereign debt crisis, which has shaken confidence and curbed domestic demand.

The REO projects that growth for all of Europe will slow from 2.3 percent in 2011 to 1.8 percent in 2012. Downside risks to growth are significant. Most importantly, the projections are predicated on the assumption that strong action is taken to contain the current crisis.

“While many important steps have been taken by the European leaders, it is now necessary to deploy quickly the new crisis management tools agreed upon at the July 21 European Summit and come together around a cooperative plan to deal with the various components of the current crisis. This is much needed to restore confidence of consumers, markets, and investors,” Antonio Borges, Director of the IMF’s European Department, said.

With growth momentum waning and financial tensions rising, the REO calls for the following actions and policy adjustments:

• Implement the new institutional architecture agreed in July by European authorities, in particular by taking advantage of the extended flexibility of the European Financial Stability Facility (EFSF).

• Keep monetary policy accommodative or even ease further as risks to growth and financial stability persist and inflationary expectations remain well anchored.

• While the deterioration in public finances leaves no option but to strengthen fiscal positions, the slowdown in growth calls for caution. Where market pressures are most severe, the consolidation should continue to be front-loaded. In other countries, where medium-term fiscal consolidation plans are credible or have been front-loaded, there is room to allow automatic stabilizers to work fully to deal with growth surprises.

• Ambitious actions to restore the ability of the banking sector to finance the economy, including measures to bring additional capital to European banks, if necessary using EFSF resources, as well as longer term liquidity facilities from the European Central Bank.

• A concerted effort to restore confidence in European sovereign debt markets, with a particular emphasis on countries that are solvent under normal market conditions.

• Boost fiscal credibility based on enhanced European governance and vigorous multilateral surveillance.

An escalation of the strains in euro area debt markets poses risks for emerging Europe1 given tight economic and financial linkages. The growing interaction has benefited both regions. However, shocks in one region increasingly affect the other and thus policy plans need to take such spillovers into greater account.

Looking to medium-term, higher growth rates would help address many of Europe’s pressing problems, the report notes. In the past decade, growth rates in GDP per capita have differed markedly among European countries. The REO discusses ways to escape low-growth traps and improve long-term economic performance.

“Europe’s growth potential is remarkable. With steady implementation of the right policies, it can be achieved”, Borges said.

1 For the purposes of the REO emerging Europe comprises (i) central, eastern and southeastern Europe with the exception of the Czech Republic and countries that have adopted the euro, (ii) the European Commonwealth of Independent States and (iii) Turkey.